Does Your Service Contract Pay?

Oct. 1, 2005
Here are some tips for ensuring that it does.

Globalization can cause headaches the world over. Just ask Carter Holt Harvey Ltd. (CHH), a New Zealand paper manufacturer based in Manukau City, Auckland. Management there decided that bold steps were necessary to get more from its equipment if the company was going to remain viable in an increasingly fierce competitive marketplace for paper. One of those steps was to pursue an operational service contract with ABB Inc., of Norwalk, Conn., for its Kinleith paper mill.

The decision made the company one of the many manufacturers that are outsourcing maintenance of their equipment. By turning maintenance over to experts on the equipment in their factories, these manufacturers are finding that they can devote their finite resources to developing their own core competencies and becoming more competitive. Consequently, they are putting effort into negotiating good service contracts.

CHH’s Kinleith paper mill is a case in point. Since ABB began managing the maintenance operation there two years ago, its experts have been able to show the mill’s employees how to keep the equipment running longer hours without spending more money. If fact, they cut maintenance expenditures by 17 percent and labor costs by 22 percent, mainly because better operational efficiency reduced the need for overtime. Meanwhile, not only did the plant’s productivity jump by 36 percent, as measured in tons produced per employee, but the company also claims that employee morale has improved.

What was the secret for the success? The simple answer is that the companies negotiated a contract that was clear and allowed both parties to prosper. Moreover, management chose what ABB calls the operational service, which was the right level of service for Carter Holt Harvey’s business. In operational services, a third party assumes responsibility for a customer’s operation, rather than just for a specific product.

“The value proposition is a supplier’s superior knowledge of how to run that [particular] operation better than the customer,” says Magnus Pousette, senior vice president, ABB Full Service North America. “Since superior knowledge of how to run an operation better is key to such services, companies that provide these services must have a deep bench of experts, both to operate the contract and to provide the ‘brainpower’ for specific issues.”

Another reason for the success of the maintenance contract is that the mill was straightforward with ABB and its employees from the beginning. “In operational service contracts, not divulging all the information needed for the supplier to be successful is the most common mistake among customers,” says Pousette. “This comes partly from a mindset conditioned by years of transactional experience where the customer has not had to share more information than necessary to buy a product or system.

He also points out that the negotiated plan must leave room for dealing with the people who might feel threatened by an outside company coming onto their turf. At the Kinleith mill, this meant working with the union representing the maintenance technicians. “The union was so positive about the contract that they walked through picket lines to work when another union staged a ‘sympathy’ strike,” says Pousette. This bold show of support convinced the other union to return to work shortly thereafter.

Choosing a provider

{1} These kinds of results depend on the service provider that you select, the kind of contract that you negotiate, and the relationship that you build. Because the expertise and capabilities of service providers vary widely, the first step to getting similar results is finding a provider that can offer the services you need. Not only should the providers demonstrate a willingness to listen to you, but they also should demonstrate competence to solve your automation problems.

Nevertheless, you should do your due diligence by checking whether a vendor can indeed deliver the negotiated level of service. Vendors are like anyone else in that they sometimes promise more than they can deliver in their exuberance to get the contract.

Another reason for due diligence is that adding services became a popular means of generating revenue among equipment builders during the recent downturn in capital equipment sales. “While many service offerings have value propositions, many suppliers cannot actually deliver the service, because they just invented it,” says ABB’s Magnus. So he advises dealing with companies that have track records of not only providing the type of services that you want, but also providing them in your region.

“In applications in which operator safety is a concern, companies should be able to rely on their service providers to address machine safety requirements, including the ability to conduct risk analyses, and then design and adjust systems for the safest and most productive operation,” says Scott Lapcewich, general manager of customer support at Rockwell Automation Inc., in Milwaukee.

Lapcewich notes that a strategy popular among some large users for choosing a service provider is to select one that can act as a prime contractor. Putting one service provider in charge can consolidate the services of many specialists and create an integrated program. By coordinating activities, the lead provider can create a base of knowledge, analyze problems and make recommendations for an entire plant based on a history of events.

Go to the source

{2} Another strategy for choosing a service provider is going back to the manufacturer of the equipment that you are using. “You have access to all of the engineering updates,” says Dave Wampfler, national manager for service products at Bosch Rexroth Corp., an automation components supplier headquartered in Hoffman Estates, Ill. “We don’t just repair; we remanufacture our products, bringing them up to our current specifications.”

Why are engineering updates desirable? “They not only enhance the product, often giving it more options and features, but they also offer a migration path for hardware and software support down the road,” answers Wampfler. Such upgrades reduce the chances of communications ports, circuit boards and other components becoming obsolete and unavailable over the years—a real concern, given the rapid pace of evolution in electronics and information technology.

Many builders also offer another warranty on the whole product. “If it comes back to us for whatever reason, other than physical damage or normal wear and tear, we repair it free of charge and make sure that it receives any other updates that have come out since the initial upgrade,” says Wampfler. “A third-party house typically offers a warranty for the specific component that it replaces.” They also tend not to have the manufacturer’s pool of engineering talent for troubleshooting and solving problems.

Besides repairing their own devices, most general automation suppliers also leverage their engineering talent by offering it for hire. In these contracts, the engineers would diagnose why a particular machine or line was failing to make its expected production quotas due to excessive downtime. The time commitment varies widely. Bosch Rexroth, for example, might not receive a call for weeks in a contract that it has with Indianapolis-based International Truck and Bus, Wampfler says. When it does, the call is for a field service technician for three or four days to work with a plant’s electrical engineers and skilled trades to solve a particular problem.

Talk to machine builders

{3} Many users procure their maintenance services from general automation suppliers that make or sell controllers, input/output devices, and drives and motors. Others, however, prefer to get them from the builders of the machine tools, injection molding machines and other machinery in their factories. These machines have highly specialized mechanical systems that require expertise beyond analyzing alert codes, replacing faulty or outdated electronics, and tweaking software. “We can do mechanical, as well as electrical and software maintenance,” says Bill Horwarth, president of Cincinnati Lamb Plus, the aftermarket service arm of machine tool builder Cincinnati Machine LLC, of Cincinnati.

This expertise, as well as the expertise in using the machine, was the reason that a defense contractor asked for Cincinnati Lamb’s help in installing three of the builder’s machines. “This customer wanted to ensure that it had our expertise on site when its people started ramping up production,” says Horwarth. “It’s been a very good contract for both the customer and us. They were able to get our expertise through the development and startup phases, rather than relying on [in-house] people who didn’t know how to operate the new machines yet.”

Cincinnati Lamb dispatched two technicians, one to install the machines and get them running, and the other to give the plant production support. The latter technician helped not only in generating prototypes of the parts to be made on the machines, but also in accommodating the inevitable engineering changes that occurred in the early stages of production. Moreover, he assists in troubleshooting electrical and mechanical problems, providing reports on repairs and modifications to the machines, and offering limited software support.

Horwarth credits the success of this job to the negotiation of a good contract. The contractor came to the table prepared with lists of specific needs, and Cincinnati Lamb returned counterproposals that avoided overcommitting its technician on site. For example, the contractor wanted the supplier to make and document any necessary changes to the proprietary software on the controllers. Because software changes often can be more complex than they appear on the surface, “we said we’ll do that, but any software that needs to be evaluated, written, modified or tested at the factory will carry an additional engineering charge per occurrence,” says Horwarth.

He adds that successful service contracts tend to details. For example, the contract with the defense contractor did much more than simply define the period of coverage and rates. It also specified the number of employees that would be on site, their hours and holidays, and the rates for calls after hours.

Reputable maintenance service providers also put a number of general details in their contracts to clarify duties and responsibilities. Cincinnati Lamb, for example, adds language releasing it from being involved in labor disputes, and defining an area for its employees to work, have access to communications lines and store tools. Another standard clause stipulates that the builder neither provides equipment such as forklifts or cranes nor carries parts and tools on consignment, unless the contract specifically says so.

The reason for the special language on consignment is that such deals require careful negotiation—well beyond size and content of the inventory. “We get into issues like how long is the consignment,” says Ron Hoffman, vice president of customer service at Cincinnati Lamb Plus. “Who has responsibility for the consignment? What happens at the end of the consignment period?”

Cutting costs, boosting profits

{4} Here again, a good service contractor can help. One that is adroit at monitoring modern automation and using software to keep records can reduce the size of these inventories. “Many people have placed spare parts in their stores simply because they don’t know how many spare parts they should have,” notes John Eva, vice president of global customer service and support at Invensys Process Systems, of Foxboro, Mass.

He says that sophisticated preventive service programs can change that by tracking use, predicting wear and egradation, and scheduling routine maintenance before they affect production. Based on actual usage data, the service manager can estimate the labor requirements, the number of spare parts that an operation will really need, and the time that they will be needed. Consequently, the manager can keep fewer parts on hand.

“With the old model, the objective was to minimize the time to repair,” says Eva. “End-users would want the parts on hand because they would need to react very quickly to failures.” Today, the new model is to maximize uptime by replacing parts before they fail.

“If a service agreement improves someone’s 92 percent process availability to 96 percent, that’s a 4 percent improvement in profit that you’ve delivered directly to the bottom line,” notes Eva. “Once you are able to get something operating at 96 percent availability, you can then optimize it to deliver between 3 percent and 10 percent improvement to the bottom line.” Even a 1 percent improvement can be very significant for high volume businesses such as oil refineries.

To maximize these returns, service providers recommend focusing on defining objectives and goals clearly and looking for services that achieve them. “A common mistake many end users make is focusing primarily on price,” says Lapcewich, at Rockwell. “Although cost is an important factor in any purchasing decision, best results typically come when the manufacturer focuses on picking the best solution based on long-term return.” In other words, concentrate on such things as process flow, training, maintenance and troubleshooting.

“This helps to ensure that the vendor fully understands the end user’s priorities and expectations about what it hopes to achieve,” adds Lapcewich. Not only will concentrating on goals allow the service provider to estimate the uptime improvements and cost reductions before it commits to an agreement, but it also will help you to calculate the savings, productivity gains and payback period of the service. Knowing the goals and objectives also will help you and the vendor to define the responsibilities of each party and to agree upon the metrics for measuring success.

Motivating providers

{5} Once this is accomplished, one way to motivate service providers, especially those that involve consulting or management, is to link payment to performance. “That means the supplier commits contractually to certain levels of performance, or it will incur a penalty,” says Pousette at ABB. “If the supplier exceeds the contractually committed performance, it shares in the value created and receives a bonus. This approach motivates the supplier to look for ways to improve services continually.”

He notes that these contracts only work if a high degree of trust exists between the customer and the supplier. “Indeed, a partnership must be formed, not necessarily in the legal sense, but in practice,” he says. Not only is extraordinary openness between the parties necessary, possibly even to the point of opening the books, but also the metrics for measuring success must be identified in advance and defined in the contract.

Rockwell’s Lapcewich points out that getting the most for your money requires actually using the service. “Organizations should view support services as an ongoing resource or tool, rather than as a last resort,” he says.

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